Practice Problems - Fiscal and Money_Solutions_1

Practice Problems - Fiscal and Money_Solutions_1 - PRACTICE...

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PRACTICE PROBLEMS – FISCAL AND MONETARY POLICY, ECO 106 1. Assume that actual output in country A is \$6,200 mill. If all resources had been used at their normal capacity, output would have been \$6,000. (i) Illustrate the situation above in a diagram. What is the labor market like in this economy? Is it difficult or easy to find a job? Is it difficult or easy for employers to find workers? The economy is producing above potential. It is easy for workers to find a job, difficult for employers to find new people to hire. (ii) What will happen in this economy over time if there is no intervention from economic policy? With no intervention from monetary or fiscal policy, the tight labor market will lead to increases in wages over time. Wage increases will increase production costs, which will shift the SRAS to the left. Output will go back to \$6,000. The price level will increase. (iii) Why may we want to use economic policy to stabilize output in this situation? To avoid the increase in prices over time. As we see, over time nothing is gained in terms of a higher output, and all we are left with is higher prices if the economy is left to itself. (iv) Assume that the government wants to stabilize output around its potential level with fiscal policy. The government has decided that it Price level (GDP deflator = 100 in 2000) P 1 0 \$6,000 6,200 Real GDP AD 1 SRAS LRAS 1

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This note was uploaded on 04/23/2011 for the course ECON 106 taught by Professor Lonning during the Fall '09 term at DePaul.

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Practice Problems - Fiscal and Money_Solutions_1 - PRACTICE...

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